You are using an outdated browser.
Please upgrade your browser
and improve your visit to our site.

Dollar Foolish

Clinton's sweetheart deal with Japan.

After Richard Nixon's re-election in 1972, Democrats accused Arthur Burns, whom Nixon had appointed chairman of the Federal Reserve in 1970, of rigging the election by overstimulating the economy. Burns, they charged, had produced a temporary reprieve from recession, but had also built up inflationary pressures that would burst forth later and produce an even sharper recession. In coming years, Republicans may make similar charges against Robert Rubin, Bill Clinton's secretary of the Treasury. With an election looming, Rubin took actions that kept the recovery buoyant, but that may have undesirable repercussions in the coming years. In private negotiations with the Japanese Finance Ministry, Rubin made an agreement to prop up the dollar against the yen.

All the outward details of this story can be completely confirmed, but some of the drama between American and Japanese officials cannot be. High-stakes economic diplomacy depends for its success on secrecy and often deception, and it is usually impossible to find out what really happened behind closed doors. I first heard the story of Rubin and Japanese finance minister Eisuke Sakakibara from R. Taggart Murphy, a former investment banker in Tokyo and author of The Weight of the Yen. Since then, I have heard further details from another banker in Tokyo and from an American official who, while not in Treasury, was privy to the details of U.S.-Japan economic policy. This official, whom I cannot identify, corrected some of Murphy's original story, but preserved the essential thrust.

The tale begins on a technical note: exchange rates. The rate at which one nation's currency exchanges for another depends on the relative strength of the two nations' economies and on their balance of trade. When one nation consistently runs trade surpluses with another, the relative value of its currency will rise, making its exports more expensive and the other country's exports cheaper, until the two countries' trading accounts balance. Or at least that's what is supposed to happen. Sometimes, though, a country will pursue a "mercantilist" strategy--it will do whatever it can, from erecting informal trade barriers to depressing domestic consumption, to preserve its trade surpluses. In that case, its currency will continue to appreciate at the expense of its trading partners. This has long been the case between Japan and the U.S. As Japan has enjoyed trade surpluses with the U.S. over the last twenty-five years, its currency has steadily appreciated and the dollar has depreciated. In 1971, the dollar was worth 360 yen. On April 19, 1995, it hit an all-time low of 79.75 yen.

At that point, however, Japanese officials began to worry that the soaring yen would finally begin to price Japanese goods out of foreign markets, putting smaller or more inefficient companies out of business. The government, which had always exported its way out of recessions, began to wonder how Japan could escape its current slump without transforming its fiscal policy. And Japan's bankers grew alarmed at what could happen to $800 billion of debt accumulated during the boom years.

That spring, the Ministry of Finance picked Sakakibara to head its Bureau of International Finance. Groomed to negotiate with Americans, Sakakibara speaks fluent English and has a Ph.D. from the University of Michigan; in 1980, he was even a colleague at Harvard of Deputy Treasury Secretary Lawrence Summers. According to sources in Japan, Sakakibara got his appointment because ministry officials thought he alone could deal with the formidable Rubin and Summers. His mission was to convince them to join Japan in revaluing the dollar at the expense of the yen.

And he succeeded. How did he do it? In an op-ed piece R. Taggart Murphy wrote last March for The New York Times, he described the Ministry of Finance as trying to get the U.S. to prop up the dollar in exchange for Japanese purchases of American Treasury bills. When I interviewed Rubin afterwards, he rejected this precise version of events. As I learned later, things seem to have transpired slightly differently. In talks with Rubin and Summers, Sakakibara stressed that Japan was on the brink of a major bank crisis--one that could directly threaten the American economy. As Japanese banks began calling in their foreign debts and cashing in their Treasury bills, American interest rates would likely soar, precipitating a severe recession in the midst of Clinton's re-election campaign. Sakakibara was probably exaggerating, but Rubin and Summers, who had been caught unawares by Mexico's debt crisis, were receptive to the message. Said one former government official, "Having been burned from misreading the tea leaves in Mexico, they were prepared to think they could get burned in Japan." They agreed to work with Japan's Ministry of Finance to raise the value of the dollar.

Rubin, the former chairman of Goldman, Sachs, was soon using his extensive connections in Wall Street to talk up the dollar. Japan's Ministry of Finance went further. The Bank of Japan began using the yen for massive purchases of dollars--it exchanged $21.5 billion in August and September 1995--driving up the price of the dollar at the expense of the yen. It then used the dollars to purchase the Treasury bills that the government auctions to pay off its debt. Sakakibara and the Ministry of Finance prodded private Japanese firms to follow suit. In August 1995, the Ministry of Finance relaxed regulations that had discouraged life insurance companies from investing their surplus overseas. Through the end of September, the five major Japanese life insurance companies bought $4.2 billion of U.S. bonds.

These huge dollar purchases have continued. According to Ron Bevacqua, an economist with Merrill Lynch in Tokyo, the Federal Reserve issued $71 billion in new debt between January and May of this year. Foreign central banks purchased $56 billion. The largest single buyer was the Bank of Japan with $20 billion, but Bevacqua claims that, when various indirect means of finance are taken into account, the Bank of Japan was responsible for purchasing "nearly half of the U.S.'s debt in the first quarter of this year."

Japan's dollar purchases, combined with relatively low interest rates in Japan, helped to drive up the value of the dollar. It topped 100 early this year and climbed to 114.92 in late October, a massive 40 percent appreciation since April 1995. Japan's actions had one immediate effect. Whether or not it was in the back of Rubin's mind, Japan's purchases of Treasury notes did help to keep interest rates down by increasing the demand for T-bills. Says Ron Bevacqua, "It has kept U.S. rates low, and because it has added to the total pool of capital in the U.S. economy, it has indirectly propped up the U.S. stock market." The economy, which sputtered in 1995, steamed ahead this year. Says Murphy, "I frankly think that Clinton owes his re-election to three people: Newt Gingrich, Alan Greenspan and Robert Rubin."

In the short run, the deal between Sakakibara and Rubin hasn't yet affected the trade balance between the two countries. Major export contracts are usually for a year and a half or more in advance. But it will in the long run--and not just with Japan, but with Asian countries where Japan has subsidiaries. By next year, the U.S. trade deficit could begin to climb, as the change in prices kicks in. American auto companies are already complaining. According to Business Week, Japanese car companies have cut prices by 1.1 percent for the 1997 model year while American firms have increased them an average of 2.8 percent. American firms will also have trouble exporting to Japan. "If this continues, we could see a major reversal in the ability of American companies to gain market share in the Japanese market," Tony Yamada, a representative of Mitsumi Enterprises, a San Francisco trading house, told The Chicago Tribune. Fred Bergsten, director of the Institute for International Economics, warns of a "huge surge in Japanese trade surplus in 1997 and especially 1998." This, in turn, would imperil the value of the dollar, force the U.S. to raise interest rates and end the economic recovery. Rubin, like Burns before him, may merely have postponed a recession.

But Rubin's actions may have even more serious consequences. His willingness to revalue the dollar eighteen months ago removed a major incentive for Japan to open up its economy to foreign trade and investment, allow unprofitable smaller firms to fold and alter its fiscal strategy to encourage domestic consumption--in short, to become a normal member of the world trading system. Says Murphy, "The United States had more leverage than usual in June of 1995, panicked as the Japanese were about the yen, and it would arguably have been easier then than at any other time in the past twenty years to overhaul the structure of U.S.-Japan relations." Instead, the U.S., haunted by the prospect of another financial collapse, allowed Japan to preserve its protected markets and trade surpluses. Brookings Institution economist Ed Lincoln, former counselor to Ambassador to Japan Walter Mondale, told the trade newsletter Sam Trade, "The abandonment of the high yen policy by the Clinton Administration in 1995 has led to a near abandonment of Japanese company efforts to deregulate the Japanese economy and lessened incentives to buy cheaper imported products." That could be bad news not only for U.S.-Japan relations, but for the world economy.

Finally, Rubin's acquiescence in Japan's practice of buying up dollars with yen and reinvesting them in Treasury bills reinforced American dependence on foreign capital to fund its debt. In the first half of this year, Ron Bevacqua estimates, foreign governments and private foreign investors purchased 95 percent of U.S. debt. Foreign governments and firms now own 27-28 percent of all American federal debt. Says Bevacqua, "When you are underwriting another country's economy, it gives you incredible leverage in negotiations with them."

Of course, Rubin can still argue that the U.S. had no choice in the spring of 1995--that the Japanese were on the verge of a financial collapse. But few economists believe that to have been the case. Said one former government official, "The Ministry of Finance sold us a bill of goods and we bought it." The price for that bill of goods did not come due during the last eighteen months. If anything, Rubin's deal with Sakakibara helped keep the U.S. economy humming during the election campaign. But it will come due soon--perhaps even before Clinton and Rubin officially begin their second term.